As we mark the three-year anniversary of the Schroder International Selection Fund BlueOrchard Emerging Markets Climate Bond[1] , we take this opportunity to reflect on the steady progress made throughout this remarkable journey. From its inception on 17th of June 2021, the fund has navigated the dynamic landscapes of both global and emerging markets with the objective of delivering robust risk-adjusted returns, while driving meaningful impact by helping to advance the United Nations Sustainable Development Goals (UN SDGs) of taking action to combat climate change. The track record of consistent performance, even amid the complexities of the global financial markets – including challenges such as COVID-19, Russia’s war in Ukraine, and persistent, sticky inflation seen across major economies worldwide – stands as a testament to the fund’s resilience.

The Fund’s Strategy for Delivering Attractive Risk-Adjusted Returns

Our investment strategy, which focuses on aiming to deliver attractive risk-adjusted returns, has proven to be both rewarding and resilient, demonstrating the value of our rigorous approach to investment selection and risk management. Our active duration management and low volatility supported the Fund’s performance over past years. Furthermore, the fund’s defensive positioning, reflected in its BBB+ rating, and a lack of exposure to economies affected by Russia’s war in Ukraine, has allowed it to outperform wider EM indices in periods of unfavourable market conditions (source: JP Morgan; Schroders).

The Expanding Universe of Labelled Bonds

The universe of labelled bonds (including green, sustainable, and sustainability-linked bonds) has seen significant expansion over the past few years[2]. In Emerging Markets, labelled bond issuance totalled $68bn in 2023, marking an increase of over four times from the $16bn recorded in 2018. In terms of allocation, labelled bonds accounted for almost 30% of EM bond supply in 2023, a significant rise from the 4.7% share in 2018 (BofA Global Research – EM ESG, 2024). The increasing diversity among issuers, in terms of both geography and sector, has provided us with a wider array of investment opportunities. We have been able to leverage this expanding universe to enhance portfolio diversification and manage risk more effectively. The growth of the labelled bond market is a testament to the increasing recognition of the importance of sustainability and the rising investor demand for such instruments. As more issuers come to market with labelled bonds, we are presented with a broader choice of investments that align with our fund’s objectives and our investors’ values.

 

Navigating Market Dynamics: Adaptive Nature of Our Investment Strategy

We believe that the size of the universe plays a key role in the fund investment management strategy. Increasing the size of the opportunity set offers options to the portfolio manager to adapt to different environments. However, more than the number of issuers, one should think about how different each investment option is. Our definition of Emerging Markets, which includes any issuer having a positive impact in Emerging Markets’ countries, allows us to have access to very different issuers. While we can position the Fund very defensively by buying AAA supranational bonds, we can also increase yield by taking idiosyncratic risk in high-yield EM corporate issuers. Moreover, our flexibility to hedge interest duration or fully screen off a specific political risk allows us to position the Fund directly based on our market view. Strict risk constraints, coupled with active portfolio management, have allowed us to manage downside risk and improve risk-adjusted returns.

A Case Study – The Sustainability Journey of Chile and CMPC

To highlight some of the fund’s investments, we present the case study of Chile. Chile has established itself as a global leader in addressing climate change, underpinned by its ambitious Climate Change Framework Law. This legislation not only demonstrates the country’s commitment to environmental sustainability but also serves as a cornerstone for its proactive approach to climate-related issues (WRI[3], 2024). This aligns perfectly with the objectives of the Fund, highlighting Chile’s pivotal role in impact finance. The country actively issues a variety of labelled bonds, including green, sustainability, social, and sustainability-linked bonds, showcasing its pioneering spirit in embracing and promoting sustainable investment practices. Chile’s high credit rating, consistently rated in the single A area by all three rating agencies, offers several benefits to the portfolio. As a sovereign issuer, the bonds are liquid instruments and the issuer is active across various durations, allowing for diversification of the fund and enhancing risk-adjusted returns. In our view, the country’s issuances are expected to outperform traditional Emerging Market hard currency bonds in a downturn.

Additionally, the fund has invested in CMPC, a Chilean pulp and paper company. CMPC was the first Chilean company to issue a green USD bond in 2017[4] and has continued to issue several labelled bonds in subsequent years. Use of proceeds include the preservation of biodiversity and restoration of forests, and sustainable forest management, among others. CMPC’s competitive market position and efficient cost structure contribute to its ability to generate attractive operating cash flow, even during market downturns.

In 2023, strengthening its innovative leadership in sustainable finance, the firm issued a new and innovative CMPC bond mixing existing ICMA standards, known as Green & Sustainability-linked bonds (GSLBs). These bonds offer a well-defined use of proceeds that are ring-fenced, along with sustainability-linked impact targets that can be tracked over time with a financial incentive for the issuer to strive towards achieving these sustainability targets[5]. This new type of bond represents a welcomed addition to the suite of labelled bonds, combining the benefits of clearly defined use of proceeds with the ability to monitor and incentivise sustainability-linked impact targets, while remaining within the realm of well-recognised frameworks.

CMPC’s GSLB is primarily focused on sustainable management of natural resources and land use, with key sustainability-linked indicators targeting 50% GHG emissions reduction by 2030. The green tranche focused on eco-efficient and circular economy adapted products, as well as the development of Water Recovery Plants[6].

Maximising Impact: Listed Debt and Best Practices in Impact Investing

Investing in listed debt can have a significant impact, both in terms of scale and democratisation of impact investing. Companies such as CMPC issuing listed debt have the ability to undertake large-scale projects that can create meaningful change while still being able to report detailed quantitative impact indicators.

Public markets can absorb large-scale investments, hence the capability of public markets to attract a significant amount of global assets for impact investments. Moreover, investors in listed debt have access to smaller investment minimum requirements that can be redeemed typically daily, opening up impact investing to retail and smaller investors. This accessibility makes impact investing more inclusive, enabling a wider range of individuals to participate in financing projects with environmental and social benefits.

In the past few years, doubts regarding the feasibility of measuring impact in public markets have been effectively addressed. The industry has made significant progress in developing powerful tools for measuring and managing impact of listed debt strategies.  Today, investing in listed debt offers an even stronger alignment with impact investing principles.

Additionally, investing in listed debt provides a strong alignment to impact investing principles, and its three pillars: intent, contribution, and measurement. The International Capital Market Association (ICMA)[7] promotes best practices and standards in the global capital markets and plays a significant role in the labelled bond market by providing guidelines and principles for issuers to follow when issuing green, social, or sustainable bonds. This helps ensure transparency and credibility in the market.

These bonds have defined eligible use of proceeds, which allows impact investors to determine whether the impact intent and planned use of proceeds align with their own impact objectives at the issuance or due diligence stage. This ring-fencing element also enables investors to finance specific impactful projects from a company or country.

Engaging with issuers to share advice and enhance impact outcomes along with mitigating sustainability risks represents one of the forms of investor impact contributions and additionality available in this asset class.

Furthermore, these bonds align with impact investing through their impact reporting requirements as they disclose pre-defined impact key performance indicators (KPIs). After one year of issuance, impact and allocation reports are disclosed, presenting the bond’s actual impact KPIs. This ensures the measurability component of impact investing is met and helps investors evaluate the level of impact they can have, both at investment and fund levels and to calculate their contribution to the SDGs.

At BlueOrchard, our B.Impact Framework process and tools are specifically designed to leverage such impactful instruments. Our robust impact calculation methodology also allows us to confidently report the impact our funds are generating through their investments. Additionally, the framework also ensures compliance with new regulations such as the Sustainable Finance Disclosure Regulation (SFDR) and the requirements of Article 9 funds. We have taken great care to align our process to comply with the regulation, by building strong in-house knowledge and expertise.

With our robust processes and tools, we are confident that we can continue to claim SFDR Article 9 status in the future. BlueOrchard’s commitment to excellence in impact management has been recognised as part of the independent verification of alignment with the Operating Principles for Impact Management (Impact Principles).  The verification was done by the independent consultant BlueMark, scoring advanced and achieving the best assessment on all eight principles, positioning BlueOrchard on BlueMark’s 2024 Practice Leaderboard[8]. This recognition underscores the effectiveness and excellence of BlueOrchard’s impact management processes.

Closing Thoughts: Navigating the Next Chapter of the Schroder ISF BlueOrchard Emerging Markets Climate Bond

Schroder ISF BlueOrchard Emerging Markets Climate Bond has demonstrated resilience and adaptability over the past three years, successfully navigating complex global financial landscapes while delivering robust risk-adjusted returns. By leveraging an expanding universe of labelled bonds and maintaining a flexible, active investment strategy, the fund has outperformed its comparative benchmark. The case studies of Chile and CMPC highlight the fund’s commitment to impactful investments that align with the UN Sustainable Development Goals. As we look to the future, BlueOrchard remains dedicated to advancing best practices in impact investing, ensuring transparency, and driving meaningful change through innovative financial instruments.

The continuous efforts to refine tools and processes, adopt innovative technologies, and seek external validation demonstrate BlueOrchard’s unwavering dedication to driving positive impact and upholding industry-leading practices in impact management.

[1] Schroder International Selection Fund is referred to as Schroder ISF

[2] Source: BofA Global Research 2024

[3] Chile’s New Governance Structures Are Streamlining Net-zero Implementation: WRI, 2024

[4] CMPC Green Bond Report, 2017

[5] CMPC Sustainable Financing Framework, March 2022

[6] CMPC Sustainable Financing & Impact Report 2022 – 2023, January 2024

[7] https://www.icmagroup.org/sustainable-finance/

[8] https://bluemark.co/practice-leaderboard/

 

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